Quick answer
On short-term secured business loans, interest can be prepaid from the advance at settlement, capitalised by adding it to the balance as it accrues, or paid monthly. Prepaying reduces the cash you receive but keeps the final balance lower. Capitalising gives you the full advance but increases the balance owed at exit. Monthly payments keep the balance flat but need cash each month.
Key points
- Prepaid: less cash up front, lower balance at exit
- Capitalised: full advance now, higher balance at exit
- Monthly: flat balance, but cash needed every month
- Choose based on cash flow during the term and exit size
- Always compare total cost and peak debt
Why interest treatment matters on short loans
On a long-term loan, interest is simply part of each monthly repayment. On short-term secured business loans, there is a choice, and it has real consequences for the business. Interest can be paid before it accrues, added to the loan as it accrues, or paid as you go. Each option changes how much cash you receive at settlement, how much you need during the term and how much you owe at the end.
Because many secured business loans are used precisely when cash is tight, the ability to avoid monthly repayments is one of their most useful features. Interest can be prepaid or added to the loan for most of the structures we arrange.
The three options
Prepaid interest. Interest for some or all of the expected term is calculated at settlement and deducted from the advance. You receive less cash, but there is nothing to pay during the term and the balance owed at exit is the original loan amount (plus any fees added).
Capitalised interest. Interest is added to the loan balance each month. You receive the full advance less any fees deducted, there is nothing to pay during the term, and the balance grows until it is repaid at the exit.
Monthly interest. You pay interest each month from the business’s cash flow. You receive the full advance and the balance stays flat, but the business needs the cash every month.
An illustrative comparison
Illustrative only, using round numbers and costs you would enter from a real quote:
| Prepaid | Capitalised | Monthly | |
|---|---|---|---|
| Loan amount | $400,000 | $400,000 | $400,000 |
| Interest cost over 6 months (from quote) | $24,000 | About $24,000 plus interest on interest | $24,000 |
| Cash received at settlement (before fees) | $376,000 | $400,000 | $400,000 |
| Paid during the term | Nothing | Nothing | $4,000 a month |
| Balance owed at exit | $400,000 | About $424,000 | $400,000 |
The bridging cost estimator calculates these figures from your own quote, including fees.
When prepaid interest suits
- you want the lowest possible balance at exit
- the advance is larger than you strictly need, so receiving less is not a problem
- you want certainty about the total interest cost
- the exit is tight, and keeping peak debt down matters
When capitalised interest suits
- you need every dollar of the advance for the business purpose
- the business cannot spare cash during the term
- the exit comfortably covers a higher balance
- the term may vary, and you prefer to pay only for the time used
When monthly interest suits
- the business has steady cash flow during the term
- you want to keep the balance flat for a refinance at a set amount
- the exit is close to the loan amount and leaves little room for growth
Peak debt and the exit
The most important consequence of the choice is peak debt: the balance on the last day. With capitalised interest, peak debt is highest. Your exit, whether a sale, refinance or payment, must repay it in full. If the exit is tight, capitalising interest can push peak debt beyond what the exit will cover. In that case prepaying some interest, shortening the term or borrowing less is safer. Our guide on how much to borrow on a bridging loan covers sizing in detail.
Ask which interest option suits your exit before you accept terms.
Early repayment and prepaid interest
If you prepay interest for twelve months and the exit arrives in eight, what happens to the unused four months? Loan terms differ. Some refund unused prepaid interest, some do not, and some charge a minimum interest period. Read the terms carefully and ask the question directly. Our guide to reading indicative terms lists the clauses to look for.
Mixing the options
Some loans combine approaches: a portion of interest prepaid at settlement, with any interest beyond that period capitalised. This can balance cash received against peak debt. Ask whether a blended approach is available.
Tax treatment
Interest on business borrowing may be deductible, and the timing of deductions can differ depending on whether interest is prepaid, capitalised or paid monthly. That is a question for your accountant, who can advise on your specific circumstances before you choose.
Mistakes to avoid
- choosing capitalised interest without checking that the exit covers peak debt
- prepaying a long term without understanding early repayment rules
- choosing monthly payments the business cannot comfortably afford
- comparing offers on headline figures rather than total cost
Illustrative scenario
Illustrative only. A builder needs $350,000 to bridge progress payments for about five months. The exit is a known payment of around $420,000 when the project completes. Capitalising interest would leave a comfortable margin. But the builder also wants to keep the balance low in case the payment is delayed and the term runs longer. He chooses to prepay interest for five months and capitalise anything beyond that. If the payment arrives on time, he repays exactly the loan amount; if it is late, the extra interest is added rather than demanded monthly.
How lenders view each option
From the lender’s side, prepaid interest provides certainty that interest for the agreed period has been received, which can make a lender more comfortable at a given LVR. Capitalised interest increases the balance over time, so the lender will check that the end-of-term LVR still sits within its limits. Monthly interest depends on the borrower’s ongoing cash flow, so the lender may ask more questions about how payments will be met. None of these is a problem in itself; each simply shifts where the lender’s attention goes.
Questions to ask before choosing
- How much cash does the business actually need at settlement?
- Can the business spare cash for monthly interest without straining wages or tax?
- What is the realistic term, and could it run longer?
- What is the minimum the exit will deliver, and does it cover peak debt under each option?
- What happens to prepaid interest if the loan is repaid early?
Writing down the answers usually makes the right choice obvious.
Fees follow similar choices
Establishment and legal fees can also be deducted from the advance or added to the loan. The same logic applies: deducting them reduces cash received, adding them increases peak debt.
Choosing with confidence
There is no universally right answer, only the one that fits your cash flow and your exit. Share your loan amount, expected term and exit, and a specialist will show you how each option affects cash received, monthly commitments and peak debt. There is no credit check when you first enquire, your enquiry stays with one team, and a clear exit figure helps us recommend the safest structure. Get a comparison.
Frequently asked questions
Is prepaid interest refunded if I repay early?
It depends on the loan terms. Some loans refund unused prepaid interest on early repayment; others do not. Check before you sign.
Does capitalised interest cost more?
Interest on interest can make the total slightly higher than prepaid or monthly interest over the same term. The difference depends on the amount and term.
Can I switch from capitalised to monthly payments?
Sometimes, by agreement with the lender. Ask what flexibility the loan allows.
Which option do most business borrowers choose?
Many choose prepaid or capitalised interest so the business has no repayments during the term.
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